Weak growth of U.S. economy in first quarter renews fears of stalled recovery

The U.S. economy’s weaker-than-expected growth in the first three months of this year renewed concerns Friday that the nation’s fragile recovery might stall. Much of the drag against growth reported Friday came from falling government spending, which raises the stakes in the difficult political fight ahead over narrowing federal budget deficits and lowering the national debt.

The U.S. economy expanded at a sluggish 2.2 percent annual rate from January through March, the Commerce Department said. Most forecasters had expected growth in the 2.5 to 3 percent range. Although the headline number for the gross domestic product – the sum of goods and services produced in the U.S. economy – came up short of expectations, the report’s component parts offered rays of hope.

Consumption remained strong in a recovering private sector, and the long-troubled housing sector appeared to be rising from the doldrums. Still, the broader GDP number was dragged down by a 3 percent drop in government spending during the first quarter, driven by an 8.1 percent decline in defense spending.

The private-sector economy grew at a 3.5 percent annual rate in the first quarter, according to Alan Krueger, the head of the White House Council of Economic Advisers.

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When combined with the monthly toll of lost jobs in federal, state and local governments – 386,000 over the past 12 months, according to the Bureau of Labor Statistics – Friday’s GDP numbers raise questions about the course of federal budget policies that will be argued throughout this presidential election year. While Democrats call for deeper cuts in military spending and Republicans want to reduce spending on social programs, both options would slow the already struggling U.S. economy.

Late this year and again next year, lawmakers in Washington are expected to try to curb future spending growth in an effort to narrow yawning budget deficits and soaring federal debt. The federal deficit – what the government spends beyond what it collects – was $1.3 trillion for the budget year that ended Sept. 30, 2011. The national debt totals $15.6 trillion.

The good news is that the first-quarter drop in defense spending isn’t expected to continue for the rest of this year – but over a longer time horizon, it must.

“The big declines in defense outlays won’t continue, but it does highlight the head winds from what will be a long period of declining government spending,” said Mark Zandi, the chief economist for forecaster Moody’s Analytics.

Meanwhile, the economy continues to grow, but not robustly.

“This isn’t boom times, but it is enough to generate enough jobs to push unemployment slowly lower,” Zandi said. “Having said this, growth in the quarter was less than expected, mostly because of sharp declines in defense spending and weak business investment.”

The real disappointment in Friday’s report was a drop in business fixed investment of 2.1 percent and in spending on business structures of a whopping 12 percent. Spending on equipment was up by only a weak 1.7 percent, which partly reflects the end of a tax break for business investment last year.

The weak business spending stood in stark contrast to a 2.9 percent increase in personal consumption expenditures. Consumers spent more even as income growth remained fairly flat.

“I think what it says is consumers are coming back a bit, but firms are still holding back. They don’t feel confident enough in the recovery to start adding to capacity” and expanding, said Bill Craighead, an economics professor at Wesleyan University in Middletown, Conn. Consumers appear to be making up for cautious spending in recent years, more confident that the worst is over, he suggested.

The same can’t be said for American businesses.

“Given corporate profits, you might have hoped for more investment growth,” Craighead said. The economy continues to “hit the snooze button. … It’s acceptable growth in the normal economy, but given how many people are unemployed it is disappointing.”

The White House put a bright face on the numbers, noting that the economy has expanded for 11 consecutive quarters.

“Auto production increased robustly, accounting for fully half of overall GDP growth in the first quarter. Residential construction increased by 19 percent, marking the first time since 2005 that residential construction has increased four quarters in a row,” White House economic adviser Krueger said on his blog. “These are encouraging signs that the private sector is continuing to heal from the worst recession since the Great Depression.”

The GDP numbers that the Commerce Department’s Bureau of Economic Analysis reported Friday are a first estimate; they’ll be revised twice as more data are collected. The revisions might help dispel the confusion that greeted the conflicting signals in the initial report.

“Private-sector hours worked rose 3.7 percent in the first quarter – what were these workers producing? The unemployment rate fell from 8.5 percent in December to 8.2 percent in March – how can this be if the economy was only growing at around its potential rate?” economists John Ryding and Conrad DeQuadros of RDQ Economics asked in a note to investors.

The RDQ economists think that the weak business-investment data understate the real strength of the recovery. They expect growth this year to be near 3 percent, higher than most forecasters project.

For Nigel Gault, the chief U.S. economist for forecaster Global Insight, the likely course is more of the same.

“Various cross-currents make it difficult to judge the second-quarter outlook, but overall we expect a similar outcome, with growth around 2 percent again,” he wrote in a research note. “The recovery looks well-founded but uninspiring.”

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